It's not just economics: S&P's political judgment

By TOM RAUM | August 8, 2011 | 5:45 PM EDT

President Barack Obama arrives to speak in the State Dining Room of the White House in Washington, Monday, Aug. 8, 2011. (AP Photo/Pablo Martinez Monsivais)

WASHINGTON (AP) — The S&P downgrade was more of a statement on the toxic political landscape in Washington than a comment on the nation's ability to pay its bills. But S&P has its own checkered history. Just a few years ago, the company gave its top triple-A rating to some of the mortgage-backed securities that helped cause the Great Recession.

Could it be wrong again?

New York-based Standard and Poor's was upfront about its focus on the political angle, citing the long standoff between President Barack Obama and Congress as a key factor in its unprecedented downgrade of the government's credit rating.

"We think the debacle over raising the debt ceiling is one illustration of that," John Chambers, head of S&P's debt rating committee, said on Monday. He said that the political gridlock and S&P's analysis of a rising U.S. debt burden in coming years prompted the downgrade.

Yet the credit-rating industry itself has been harshly criticized since the financial crisis of 2008-2009, and S&P's downgrade seems certain to increase congressional scrutiny.

The company was hardly revealing anything that wasn't already well known by financial markets, politicians, analysts and probably most everyday Americans: The divisive political atmosphere in Washington has been leading to near-paralysis.

But is the rating agency qualified to make political as well as economic judgments?

"We didn't need a rating agency to tell us that we need a balanced long-term approach to deficit reduction. That was true last week. That was true last year. That was true the day I took office," Obama said Monday in his first remarks on the subject since the downgrade. "And we didn't need a rating agency to tell us that the gridlock in Washington over the last several months has not been constructive, to say the least."

But, he said, Washington has the power to fix its own political dysfunction. Furthermore, Obama asserted, "No matter what some agency may say, we've always been and always will be a triple-A country."

Making its own judgments, Wall Street dumped stocks all day long. The Dow Jones industrials closed down 634.76 points — or 5.5 percent — in the first day of trading since the S&P downgrade.

Some lawmakers and economists have questioned whether the ratings agencies have the competence to evaluate the country's finances, based on their own performance prior to the 2008-2009 financial crisis.

S&P predicated its downgrade "on the theory that Washington might deliberately refuse to pay its debt because of a political impasse. But I don't know what makes them experts at this," said Rep. Brad Sherman, D-Calif., a member of the House Financial Services Committee.

"S&P's main job is rating private issuers, and they have some expertise in that, although obviously they got it pretty wrong in mortgage-backed securities," Sherman said.

"I find it interesting to see S&P so vigilant now in downgrading the U.S. credit rating," said Sen. Bernie Sanders, I-Vt. "Where were they four years ago?"

Leading up to the financial meltdown in 2008, S&P and its sister credit-rating agencies gave coveted AAA ratings to some of the very mortgage-backed securities that later became nearly worthless, leading to staggering losses for many investors and funds. Also, the rating agencies had awarded top ratings to some of the financial firms that failed.

That gave them a black eye, and some analysts have suggested the S&P downgrade of U.S. debt was partly an effort to restore some of the lost confidence in the agencies' ratings.

Stephen Hess, a former presidential adviser and a senior fellow emeritus in governance studies at the Brookings Institution, said S&P's political discourse caught him by surprise.

"It suggests either that those of us on the outside either don't understand what rating services do, or that there's a new style there," Hess said. "I felt I was reading a political judgment from an organization that I expected only gave financial judgments or economic judgments. It went well beyond the question of data."

But Nigel Gault, chief U.S. economist with HIS Global Insight, based in Lexington, Mass., said he saw no problem with rating agencies delving into political matters.

"If they're looking at Greece, for instance, they've got to consider whether or not the political system is able to take the action to stabilize debt," said Gault. "You're not looking at pure economics here because fiscal policy decisions are political decisions."

Furthermore, Gault said, "there could be a default not because you can't pay but because you choose not to pay. We got quite close to that."

Neel Kashkari, a managing director at bond-fund giant PIMCO, said the recent budget deal made none of the hard choices that will be needed to bring the government's budget closer to balance.

Kashkari, who earlier ran the government's $700 billion bank bailout fund, told CNBC: "Until Republicans and Democrats show an ounce of backbone and do what's in the interest of the American people, rather than what's in their own immediate political interest, I can't argue with S&P's conclusion."

Standard & Poor's Financial Services is a subsidiary of The McGraw-Hill Companies, which publishes financial research and analysis on stocks and bonds. Tracing its roots back to the 1860s, S&P is also known for its stock index of 500 large U.S. companies.

The other two major credit-ratings agencies, Moody's Investor Service and Fitch ratings, also have warned of downgrades. But they have not joined S&P in doing so — for now.

The S&P action could lead to higher interest rates by making Treasury bills and bonds less attractive.

However, in practice, interest rates on Treasurys are already so low — and globally there are few safe-haven alternatives — that many analysts suggest it unlikely the downgrade would significantly affect the interest rates the U.S. government pays on its $14.3 trillion in debt.

The largest foreign holders of U.S debt — China and Japan — have not signaled plans to dump their U.S. securities. Still, China strongly condemned America's "addiction to debts."

It was federal debt that got downgraded — U.S. bonds — but so far stocks are taking the biggest hit.